Sunday, August 17, 2008

CXW: Go Directly to Jail, Do Not Pass Go, Do Collect Big Returns.

Sometimes it seems to me that investors overlook some potentially high returns by overlooking "boring" companies. Occasionally I even find myself overlooking such companies. I think it's easy to get lost in the exciting share price swings of a company like Apple (AAPL) and while there is great money that can be made by taking advantage of such volatile price swings, it is important to recognize that there are other less "sexy" ways to make a healthy return.

It might seem unbelievable to you when I say that a fundamentally sound company with solid, consistent and guaranteed revenues can be an overlooked stock that trades below $30 dollars a share. However, the Corrections Corporation of America (CXW) is such a company.

Corrections Corp. has solid fundamentals and a history of profitability. Better yet, this privatized prison and jail operator has a consistent source of revenue that comes from contracts with 19 states and the district of Columbia. They operate 65 facilities and house over 72,000 inmates at all security levels.

My favorite thing about Corrections Corp. has to be the consistent revenue inflows. Since they operate under government contracts and have shown a tendency to re-negotiate these contracts in their favor in the face of rising costs, I simply do not see how this company could ever lose money. The biggest burden upon the company's management is to control costs while still maintaining the integrity of their facilities, but they have proven themselves capable of doing just that and the company has thus showed consistent profitability.

Given the above facts many of you must be wondering how is it that Corrections Corp. can be trading at below $30 a share. The answer to that it that because Corrections Corp. has such a consistent and guaranteed stream of revenues, their profitability and return to investors is easy to predict. That predictability is the precise reason that Corrections Corp. is deemed to be a "boring" stock and that is why it is overlooked.

In it's current state, Corrections Corp.'s revenue and profit will remain roughly the stable which would limit the share price growth. So, in its current state I would not recommend CXW for an investor or for a trader because it just cannot offer impressive returns to shareholders.

The reason that I do like CXW for a long term investment is that I think that the privatized corrections industry, of which they are the most dominant player, is destined to grow. Basically, the more inmates and more facilities that Corrections Corp. manages the more revenue they receive from state governments. More growth offers more returns and higher share price.

Why do I think that the privatized corrections industry is destined to grow? I think that because the prison population is constantly growing. According to the non-partisan Pew Center on the States, as of June 30, 2007 there were 2.3 million prisoners in America's prisons and jails. The cost of housing these inmates costs 55 billions dollars annually in taxpayer dollars.

The rate of incarcerated persons in the United States is growing at a much faster rate than the general population of the United States. A projection done in 2007 by the Pew Center on the States projected a 13% increase in prison inmate population from 2007 to the end of 2011 while the general population of the United States is only expected to grow 4.5% during that same period.

Currently privatized prisons and jails only represent a small fraction of the overall prisons and jails in the United States, but that is a trend that is slowly changing. Many governments are starting to see the value and cost savings that can come by outsourcing their correctional operations.

The overcrowding that plagues government operated prisons tends not to affect their privatized counterparts as greatly because the privatized facilities in many cases can cap the number of inmates. In 2007 when prison overcrowding rates in some government operated facilities reached as high as 114% of designed capacity, the private prisons were able to absorb, with compensation from the respective governments of course, 77,987 inmates from these overcrowded state and federal prisons.

When you add together overcrowded prisons and an explosive inmate growth rate, the only answer is that more prison capacity is needed. Corrections Corporation of America will stand to benefit from this trend and this should add the necessary growth and revenue to pump up their bottom line and their share price.

I am generally an options trader, but Corrections Corp. is not a company that I would try to trade options on because their share price simply does not show the type of volatility that is necessary to profit on options. The only play on CXW that will allow for an investor to catch the overall long term trend will be a long term investment.

There is always a chance that Corrections Corp. will not show the type of explosive growth that I mention above, but the beauty of this long term play is that there is not a lot of downside even if CXW shows minimal growth. Even in the absence of future growth, CXW will still have a steady stream of revenues and probably a share price comparable to what it is today.
(Disclosure: None)

Happy Investing


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